Amalgamations, Absorption, and Reconstruction of Companies | Commerce & Accountancy Optional Notes for UPSC PDF Download

Introduction

• Companies engaging in joint stock ventures often opt for combining their operations to achieve economies of scale and mitigate intense competition. This consolidation can take the form of either Amalgamation or Absorption.
• Amalgamation:
  • Definition: Amalgamation occurs when two or more companies, identical in all aspects, undergo liquidation. Subsequently, a new company is established to inherit their business operations.
  • Example: If a newly formed company, say C Ltd., is created to acquire the existing companies A Ltd. and B Ltd., it is a case of amalgamation.
• Absorption:
  • Characteristics: Absorption involves the acquisition of one existing company by another, without the formation of a new entity.
  • Illustration: In absorption, an established company assimilates another existing company into its operations.
• Corporate entities undertake these strategies to streamline operations, enjoy synergies, and navigate competitive landscapes effectively.

Objectives of Amalgamation

• Definition of Amalgamation:
  • Amalgamation means when two or more companies merge to either eliminate competition or grow in size for cost efficiency.
  • It's a broad term covering mergers (companies uniting) and acquisitions (one company buying another).
• Objectives of Amalgamation:
  • Market Control and Expansion: Gain better control over the market, increase market share, and expand the business area.
  • Competition Elimination: Stop intense competition and rivalry among the merging companies.
  • Economies of Scale: Enjoy cost advantages by producing on a larger scale.
  • Professional Expertise: Utilize the skills of professional experts.
  • Increased Funds: Have more funds available for future investments.
  • Overall Advantages: Achieve various benefits that come with combining companies.

Reconstruction

• Definition of Reconstruction:
  • Reconstruction is different from amalgamation; its goal is to reorganize a company facing significant losses.
• Types of Reconstruction:
  • External Reconstruction:
    • The existing company is closed down, and its business is sold to a newly formed company, often with a similar name and owned by the same shareholders.
  • Internal Reconstruction:
    • The company stays intact legally but undergoes internal reorganization.
    • Involves rearranging and reducing the share capital.
    • Share capital is adjusted to its actual value, and the funds are used to clear accumulated losses, remove fictitious assets, and reduce the value of overvalued assets.

Difference between Amalgamaton, Absorption and Reconstruction

Important Terms in Amalgamation

(1) Transferor Company:

• The company being amalgamated into another.

(2) Transferee Company:

• The company into which the transferor company is amalgamated.

(3) Types of Amalgamation: 

• Amalgamation in the nature of merger:
  • Conditions include transferring all assets and liabilities to the transferee company.
  • 90% or more equity shareholders of the transferor company become equity shareholders of the transferee company.
  • Consideration for amalgamation is paid through issuing equity shares in the transferee company.
  • Business of the transferor company continues in the transferee company.
  • No adjustments to the book value, except for accounting policy uniformity.
• Amalgamation in the nature of purchase:
  • Doesn't meet all conditions mentioned for merger-type amalgamation.

(4) Assets purchased and Business purchased:

• If the transferee company purchases assets, it means acquiring all assets (including cash) but not liabilities.
• If the business is purchased, it includes acquiring all assets and liabilities.

(5) Liabilities and Trade Liabilities:

• Liabilities: Includes trade creditors, bills payable, debentures, bank overdraft, outstanding expenses, pension fund, provident fund, workmen profit sharing fund, etc.
• Trade Liabilities: Specific to creditors and bills payable related to the sale/purchase of goods and services.

Methods of Accounting for Amalgamation

• Two Main Methods of Accounting for Amalgamation:
  • Pooling of Interest Method:
    • Used when amalgamation is in the nature of a merger.
    • Assets, liabilities, and reserves of the transferor company are recorded by the transferee at their existing values (adjusted if necessary).
    • If conflicting accounting policies exist, a common set is adopted after amalgamation.
  • Purchase Method:
    • Applied for amalgamations in the nature of purchase.
    • Transferee company accounts for the amalgamation by either incorporating assets and liabilities at their current values or allocating consideration to individual assets and liabilities based on their fair values at the amalgamation date.
    • Identifiable assets and liabilities may include those not initially recorded in the transferor company's financial statements.
• Pooling of Interests Method:
  • Assets, liabilities, and reserves are recorded at their existing carrying amounts by the transferee company.
  • In case of conflicting accounting policies, a uniform set is adopted post-amalgamation.
  • Any changes in accounting policies due to the amalgamation are reported following standard accounting procedures.
• Purchase Method:
  • Transferee company incorporates assets and liabilities either at existing carrying amounts or based on fair values at the amalgamation date.
  • Fair values may be influenced by the transferee company's intentions, such as specialized use for an asset or planned changes in the transferor company's activities.
  • Specific provisions may be made for expected costs, like employee termination or plant relocation.

Treatment of Reserves on Amalgamation

• Preservation of Reserves in Merger:
  • If amalgamation is a 'merger,' the reserves from the transferor company keep their identity in the financial statements of the transferee company.
  • Examples: General Reserve of the transferor becomes General Reserve of the transferee; Capital Reserve and Revaluation Reserve also retain their identity.
  • Reserves available for distribution as dividends before the amalgamation remain available after it.
  • The difference between recorded share capital issued and the transferor company's share capital is adjusted.
• Non-Preservation of Reserves in Purchase:
  • In a 'purchase' type amalgamation, the identity of reserves (except statutory reserves) is not preserved.
  • The consideration amount is subtracted from the net assets' value of the transferor company acquired by the transferee.
  • If the result is negative, it's treated as goodwill arising from amalgamation.
  • If the result is positive, the difference is credited to Capital Reserve.

This distinction in handling reserves helps understand how financial statements reflect the amalgamation type, whether it's a merger where reserves maintain their identity or a purchase where they do not.

Treatment of Goodwill arising on Amalgamation

• Goodwill Treatment:
  • Definition: Goodwill arising from amalgamation is a payment made in anticipation of future income.
  • Treatment: It's considered an asset and is systematically amortized (gradually written off) over its useful life.
  • Challenge: Estimating the useful life of goodwill is often challenging; it's prudently estimated.
  • Amortization Period: Typically, goodwill is amortized over a period not exceeding five years, unless a slightly longer period is justified.
• Balance of Profit and Loss Account:
  • Merger Nature:
    • In 'amalgamation in the nature of a merger,' the Profit and Loss Account balance of the transferor company is combined with the corresponding balance in the transferee company's financial statements.
    • Alternatively, it may be transferred to the General Reserve.
  • Purchase Nature:
    • In 'amalgamation in the nature of purchase,' the Profit and Loss Account balance of the transferor company loses its identity in the financial statements of the transferee company.

Purchase Consideration

• Purchase Consideration Definition:
  • It's the amount paid by the acquiring (transferee) company for buying the business of another (transferor) company.
  • It includes shares, securities, and cash paid to the shareholders of the transferor company.
  • Liabilities taken over by the acquiring company are not part of the consideration.
• Calculation Methods:
  • Lump Sum Payment Method:
    • A fixed sum is agreed upon and paid by the acquiring company.
    • Example: If Company A purchases Company B's business for Rs. 25,00,000, it's a lump sum payment.
  • Net Assets Method:
    • Purchase consideration is based on the net worth of the assets acquired by the acquiring company.
    • Only assets acquired and liabilities taken over are considered.
    • Goodwill is included, and fictitious assets are excluded.
  • Net Payment Method:
    • Purchase consideration is calculated by adding all payments (shares, securities, cash) made by the acquiring company.
    • Liabilities taken over are not deducted, making it the total of all payments.
  • Intrinsic Worth/Value Method:
    • An extension of the net assets method.
    • Calculates purchase consideration based on the intrinsic value of shares.
    • Intrinsic value is the net assets available for equity shareholders divided by the number of equity shares.
• Considerations for Calculation:
  • Assets and liabilities taken over are considered in Net Assets and Intrinsic Value methods.
  • Payments made for shareholders, whether in cash or shares, are crucial in determining the purchase consideration.
  • If debentures and creditors are taken over and subsequently discharged, this amount is not deducted from the consideration.

Summary

• Amalgamation vs Absorption:
  • Amalgamation:
    • Similar companies liquidate and form a new company to take over the business.
    • Objectives include better market control, eliminating competition, increasing funds, utilizing professional expertise, and enjoying economies of scale.
  • Absorption:
    • One existing company purchases another existing company.
• Objectives of Amalgamation:
  • Better market control and increased market operations.
  • Elimination of competition and rivalry among amalgamating companies.
  • Enhanced availability of funds for future investments.
  • Utilizing the services of professional experts.
  • Enjoying economies of large-scale production.
• External vs Internal Reconstruction:
  • External Reconstruction:
    • Reorganizing a company to offset huge losses.
  • Internal Reconstruction:
    • Company continues with its legal entity and undergoes internal reorganization.
    • Involves reducing share capital to its real worth to write down overvalued assets.
• Methods of Accounting for Amalgamation:
• Pooling of Interest Method: Assets, liabilities, and reserves of Transferor Company are recorded by Transferee Company at their existing carrying amounts.
• Purchase Method: Transferee company accounts for amalgamation by incorporating assets and liabilities at existing carrying amounts or fair values at the amalgamation date.
• Purchase Consideration in Amalgamation: Amount paid by the transferee company for the purchase of the transferor company's business. Calculated through methods like lump sum payment, net assets, net payment, and intrinsic worth.